ceive a series of principal payments un-
til the principal has been fully paid. The
principal The capital or face amount of
total amount of principal to be paid is
a debt or other obligation upon which
fixed so once fully paid, the PO termi-
interest accrues.
nates. If interest rates decline, mort-
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principal-only securities–profit diagram
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137
gagors accelerate repayment with the
only be sold to qualified investors.
result that the cash flows to the PO
Qualified investors include most insti-
holder are accelerated. Cash flows re-
tutional investors and others who meet
ceived sooner have greater value than
specified criteria. Securities sold through
cash flows received later, so PO in-
private placements are often highly
vestors benefit significantly from a de-
structured and tailor-made to suit the
cline in mortgage interest rates.
needs of the issuer and the investor,
whose needs can be quite different. Pri-
principal-only securities See principal
vate placement eliminates the registra-
only.
tion delays associated with public
offerings of securities. However, such
principal-only strip See principal only.
securities can be resold only to other
qualified investors and, as such, are far
principal-protected equity-linked notes
less liquid than registered securities.
Equity-linked debt instruments that
pay a coupon equaling some fraction of
privilege An early term for an option.
the total return on some benchmark
See option.
equity index and protect the value of
the principal so that the debt holder is
proceeds to the issuer The amount of
assured of getting all of the principal
money to be paid to the issuer of secu-
back at maturity. Some earlier versions
rities by the underwriters upon com-
of equity-linked notes paid a coupon
pletion of the distribution. In a firm
that was equal to some fraction of the
commitment underwriting, the pro-
total return on some benchmark equity
ceeds to the issuer is a contractual com-
index (e.g., the S&P 500). If the total re-
mitment. If the securities are sold at the
turn on the equity index turned out to
offering price, then the difference be-
be negative for a coupon period, the
tween the gross proceeds from the sale
coupon would be negative. This would
and the proceeds to the issuer is the un-
be dealt with by reducing the principal.
derwriting spread.
These instruments were not attractive
to investors because of the potential
profit diagram A graphic portrayal of
loss of principal. The principal-protected
the profit from an investment as of a
feature eliminates this risk.
certain point in time under a range of
values for the underlying asset. Often
private equity sale A discounted pri-
drawn to depict the profit potential of
vate sale by a holder of restricted stock
option strategies but can be drawn for
to a counterparty who holds the stock
any instrument. Closely related to
until it is freely tradable or otherwise
profit diagrams are value diagrams,
further monetizes it or sells it pursuant
which indicate the value of a position
to an exemption from registration. Typ-
for a range of prices for the underlying.
ically, the original holder loses all con-
For futures contracts, profit diagrams
trol and equity ownership in the stock
and value diagrams are the same. For
and receives less than 100% of the cur-
option contracts, however, the value
rent market value of the stock, but has
diagram has to shift to reflect the pre-
no economic risk in the position going
mium paid (or received) from the op-
forward.
tion’s purchase (or sale) before it can be
used as the profit diagram. Closely re-
private placements Corporate security
lated to profit diagrams are payoff pro-
issuances that are exempt from regis-
files and risk profiles, terms often used tration with the SEC and which can
interchangeably .
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profit-share option–public offerings
profit-share option See participating op-
option that is purchased is written on
tion.
an underlying asset that is the same as,
or very similar to, the asset that is held
profit-sharing forward See participating
long. For example, an investor might
forward.
have a long position in IBM stock. If he
purchases a put option on IBM stock in
program trading The buying and sell-
order to protect the value of his long
ing of baskets of stocks, often as bun-
position in IBM stock, the put would be
dles, for purposes of replicating indexes
said to be a protective put.
and/or trading baskets of stocks against
stock index futures. To find exploitable
provisional call protection Aside from
arbitrage opportunities, thousands of
hard call protection, some convertibles
hypothetical baskets of securities must
also possess provisional call protection.
be considered in a very short period of
That is, they cannot be called prior
time, necessitating the use of auto-
to the provisional call date unless the
mated algorithms to both find appro-
common trades above a certain price,
priate baskets and generate the trades.
typically from 40% to 50% above the
See cash-index arbitrage.
conversion price, for a specified period
of time.
promised yield See yield-to-worst.
prudent-investor rule A rule that re-
promissory note Any of a variety of
quires a fiduciary to discharge his or
debt instruments evidenced by a note
her duties with the same care, skill, and
promising to repay borrowed money
diligence that a prudent person acting
together with interest according to a
in this capacity under the circum-
specified repayment schedule.
stances then prevailing who is familiar
with such matters would use to con-
prospectus A document that describes
duct an enterprise of like character and
all of the terms and risks surrounding a
with like aims.
public offering of debt or equity and
which provides important information
PSA Acronym for Public Securities
concerning the issuer of the securities.
Association. Also used in reference to
A prospectus must be provided to an
principal prepayment assumptions as
investor prior to the sale of the securi-
generated by the Public Securities As-
ties to the investor.
sociation from historical data on mort-
gage lending.
protective covenants Provisions written
into a bond or other debt instrument’s
pseudo-coupon date A date on which a